A:

Taxpayers can ease the pain of preparing tax returns simply by knowing the Internal Revenue Service's (IRS) definitions of certain significant terms that have major impacts on taxable income. Some of the most important accounting terms for taxpayers to know include gross income, adjusted gross income and modified adjusted gross income (MAGI).

Gross Income

An individual’s gross income is simply his or her total earnings, not otherwise exempt from taxation, throughout any given year. Wages, salaries, commissions and net business income are included in the gross income tally, and this number is used to determine whether an individual needs to file a return or if a person can claim an individual as a dependent. If gross income is less than a certain amount, filing a tax return may not be necessary.

Adjusted Gross Income

An important accounting figure helpful in determining an individual’s total taxable income in a given year is adjusted gross income. This figure is determined by subtracting adjustments, or above-the-line deductions, from an individual’s gross income. Adjustments can include traditional IRA contributions eligible for deduction; qualified retirement plan contributions; payment of alimony; and interest paid on student loan balances. For the self-employed, health insurance premiums and one-half of self-employment taxes paid throughout the year also affect adjusted gross income.

The adjusted gross income calculation is important to an individual’s tax return as it is used to determine a person's eligibility to take additional deductions to further reduce taxable income. Both state and federal tax preparations require the calculation for adjusted gross income to be completed properly to determine further deduction eligibility.

Modified Adjusted Gross Income

Where most taxpayers get confused in preparing their tax returns is the process of calculating modified adjusted gross income. This figure differs from adjusted gross income in that some adjustments are added back in to the total. These adjustments can include tuition costs and education deductions, any eligible IRA contributions, losses from rental properties and interest paid on student loans. Self-employed individuals need to add back in half of self-employment taxes paid as well. The MAGI is used to determine whether certain deductions are allowed, including contributions to an individual retirement plan.

For most individuals, adjusted gross income and MAGI are similar; however, both must be calculated to determine total taxable income for any given year. Regardless of whether an individual receives a W-2 or is self-employed, understanding the differences between gross income, adjusted gross income and MAGI is a necessary aspect of filing a correct tax return. The majority of tax preparation software programs perform these calculations behind the scenes, but individuals can more accurately estimate total tax obligations for the year when they have an understanding of these income terms.

RELATED FAQS
  1. What is the difference between taxable income and gross income?

    Understand the basic differences between the terms gross income and taxable income, and what is included in the total of ... Read Answer >>
  2. What is the difference in tax liability between gross income and other kinds of income?

    Find out how the U.S. government taxes worker's earnings, whether it is gross income or income exempted or excluded from ... Read Answer >>
  3. Are gross sales and taxable gross sales the same thing?

    Learn the difference between gross sales and taxable gross sales and how these terms relate to the profit and tax liability ... Read Answer >>
  4. What are some good free online calculators for AGI (adjusted gross income)?

    Learn specific information about adjusted gross income and modified adjusted gross income and where free online calculators ... Read Answer >>
Related Articles
  1. Taxes

    How To Calculate AGI For Tax Purposes

    Determining your adjustable gross income is essential in the tax filing process. Here are some tips for doing so.
  2. Taxes

    What's IRS Form 1040 For?

    Most U.S. taxpayers will be familiar with the 1040. By the end of filling it out, you'll know how much tax you owe, or what your refund is.
  3. Investing

    Understanding the Income Statement

    The best way to analyze a company - and figure out if it's worth investing in - is to know how to dissect its income statement. Here's how to do it.
  4. Small Business

    How Gross Margin Can Make or Break Your Startup

    Find out how your startup's gross margin can impact your business, including why a mediocre margin may spell disaster for a budding business.
  5. Taxes

    Taxes: Who Pays And How Much?

    When it comes to taxes, the debate is endless on who pays what, especially in Congress. With no new initiatives in sight, let's take a look at who is paying now.
  6. Retirement

    Avoid the Social Security Tax Trap

    Government benefits can cost you big money! Know the income thresholds before you file.
  7. Taxes

    How to Reduce Risk With Tax Diversification

    Is your retirement income adequately diversified from a tax standpoint?
  8. Taxes

    Countries with the Highest Income Taxes

    Before you move to one of these countries with the highest income taxes, think through the overall tax situation - and what you get for your money.
  9. Insights

    Top Tax Issues For High-Net-Worth Individuals

    Wealth brings benefits, but from a tax perspective it creates special challenges. Here are some tax issues to pay attention to.
  10. Taxes

    How The Wealthy Slash Their Income Tax Bills

    Many of these tax-minimization strategies can be used by anyone. Find out how you can pay taxes like a millionaire.
RELATED TERMS
  1. Adjusted Gross Income - AGI

    Adjusted gross income (AGI) is a measure of income calculated ...
  2. Modified Adjusted Gross Income - MAGI

    Modified adjusted gross income (MAGI) is the amount used to determine ...
  3. Gross Profit

    Gross profit is the profit a company makes after deducting the ...
  4. After-Tax Income

    The amount of money that an individual or company has left over ...
  5. Future Income Tax

    Income tax that is deferred because of discrepancies between ...
  6. Income

    Income is money that an individual or business receives on a ...
Hot Definitions
  1. Yield Curve

    A yield curve is a line that plots the interest rates, at a set point in time, of bonds having equal credit quality, but ...
  2. Gross Profit

    Gross profit is the profit a company makes after deducting the costs of making and selling its products, or the costs of ...
  3. Risk Tolerance

    The degree of variability in investment returns that an individual is willing to withstand. Risk tolerance is an important ...
  4. Donchian Channels

    A moving average indicator developed by Richard Donchian. It plots the highest high and lowest low over the last period time ...
  5. Consumer Price Index - CPI

    A measure that examines the weighted average of prices of a basket of consumer goods and services, such as transportation, ...
  6. Moving Average - MA

    A moving average (MA) is a widely used indicator in technical analysis that helps smooth out price action by filtering out ...
Trading Center